PE Shores Up Flagstar, Buffers U.S. Tarp Stake

The same day that the $14.2 billion-asset thrift company got more than $500 million in capital from a private-equity firm and the government, it posted a $200 million quarterly loss and announced even more capital is on the way from MatlinPatterson Global Advisors LLC.

Observers say Flagstar, of Troy, Mich., is an example of how private equity could help the Treasury Department protect its investments under the Troubled Asset Relief Program, and that they expect to see more cases where the government requires private capital.

Like Flagstar, the $948 million-asset Bridge Capital Holdings in San Jose raised $30 million from a private-equity group before receiving $23.8 million through Tarp.

And Colonial BancGroup Inc. in Montgomery, Ala., said last week that it needed to raise $300 million to access $550 million in government capital under Tarp.

Flagstar nailed down $250 million from MatlinPatterson, and just over $266.6 million of Tarp funds followed.

But then Flagstar revealed Friday that it lost $200 million in the fourth quarter, more than six times its net loss a year earlier — wiping out more than a third of the capital it has just raised.

MatlinPatterson is now investing another $100 million, bringing its ownership of Flagstar over 70%. Flagstar executives also invested $5.3 million.

It's further proof of the power private equity is flexing in banking today.

"If private equity is going to match the Tarp, they will do everything necessary to make it work and raise more capital," said Dan Bass, the managing partner in the Houston office of the investment bank Carson Medlin Co.

"The mere presence of private equity does provide an additional layer of protection that wouldn't have existed otherwise," said Brian Mellone, the managing director of fixed-income banking for Regions Financial Corp.'s Morgan Keegan & Co.

Terry McEvoy, an analyst with Oppenheimer & Co. Inc., said Flagstar faces further losses, "but it seems like the fund is investing for the opportunity longer down the road, but first they need to clean up the problems in order to take advantage of those opportunities."

MatlinPatterson said in December that it was drawn to Flagstar's "leading mortgage origination platform and quality balance sheet."

Shivan Govindan, the president of Resource Financial Institutions Group, a New York private-equity firm, said he thinks the Treasury is requiring some companies to raise capital on their own before receiving Tarp as a way to be more flexible in doling out funds and to better ascertain which banks might survive.

"I think the government became concerned that they were being arbitrary, or they were flat-out making mistakes" when rejecting some companies, Mr. Govindan said.

So the government told the iffy banks: " 'If you can find private capital, we'll match it.' The banks that are able to find private capital, are, by definition, stronger."

Joe Ford, a partner in the Austin office of DLA Piper, said he expects the Treasury requirement for private equity to become more common.

On the flip side, he said, private-equity firms looking to make investments also will want to see that a company is of high enough quality to receive the government capital and will make their involvement contingent on Tarp more often.

At the end of the fourth quarter, Flagstar's capital levels had fallen to merely "adequately capitalized," with total risk-based capital ratio of 9.31%. But the $523 million raised on Friday would have boosted its capital to 14.78% at the end of the quarter.

During a conference call Friday, Thomas Hammond, Flagstar's chairman, said it plans "to operate with higher regulatory capital than we have in recent years." The fourth-quarter loss was driven by a $176.3 million provision for loan losses, double the provision for the third quarter and up 363% from a year earlier.

Loan production dropped 20%, to $5.4 billion, as Flagstar "shifted our focus away from new loan production to focus on capital preservation and increased liquidity," Mark Hammond, its vice chairman, chief executive officer, and president, said during the call.